Last updated: 09:34 / Tuesday, 2 September 2014
Insight by ING IM

The Two Sides of The French Equation

Imagen
The Two Sides of The French Equation
  • The most promising recipe to solve the problems on both the demand as well as the supply side is to implement policies on both sides of the equation
  • Structural reforms are of little use if there is insufficient demand to move resources towards industries with a higher productivity
  • The policy prescriptions applied within the euro area have all focused on structural reform while too little attention was given to the need for demand stimulus
  • The new Economy minister is a proponent of these reforms but remains relatively silent on the need for demand stimulus

The French economy faces problems on both the demand as well as the supply side. On the demand side it suffers from very sluggish spending growth where it is underperforming many of its EMU peers. Meanwhile, there are also formidable structural problems such as a low rate of profitability, a deterioration in competitiveness and too little flexibility in labour and product markets, expains Willem Verhagen, Senior Economist Multi-Asset ING IM.

The most promising recipe to solve all this, which was in fact advocated by Draghi in his Jackson Hole speech, is to implement policies on both sides of the equation. Structural reforms are of little use if there is insufficient demand to move resources towards industries with a higher productivity. Similarly, well-targeted reforms can raise business confidence and enhance the effectiveness of demand stimulus.

Until recently, the policy prescriptions applied within the euro area have all focused on structural reform while too little attention was given to the need for demand stimulus. Until early 2013 there was even a huge fiscal contraction on the region wide level which, combined with the fall-out from the euro crisis, played a big part in the double dip recession of 2011/12.

Meanwhile, monetary policy was insufficiently loose to generate sufficient traction in overall demand. Since then, policy actions have improved as the pace of fiscal consolidation has come down while monetary policy has been eased. However, so far this is still not enough to substantially reduce the degree of slack in the economy.

French politics has wrestled a lot with the seemingly opposing demand and supply side policy prescriptions over the past few years. Before he became President Hollande campaigned on the need to generate growth but once he was in office he was quickly confronted with the fiscal straight jacked imposed by Brussels. With the appointment of Prime Minister Valls the French government became decisively more open to implementing difficult but needed supply side reforms but the recognition that demand stimulus is also needed was never completely lost. Outgoing economy minister Montebourg was very vocal in his call for less fiscal austerity but at the same time opposed structural reform. The new Economy minister is a proponent of these reforms but remains relatively silent on the need for demand stimulus.

All in all, France thus seems to have moved closer to the policy views of Brussels and Berlin which could possibly come at the cost of more domestic political problems as the support for the government in Parliament becomes thinner due to the risk of split in Hollande’s party. Partly because of this, this move could, however, perhaps paradoxically increase the leverage of France in the European debate on the need for more demand stimulus. There is an increasing recognition within the EC that the flexibility within the Fiscal Compact should be used to ease the fiscal side of things further. As argued before, the ECB is now also coming around to this view.

menu
menu